Last checked at 4 Apr 2023 07:00
LONDON STOCK EXCHANGE ANNOUNCEMENT
THE MERCANTILE INVESTMENT TRUST PLC
FINAL RESULTS FOR THE YEAR ENDED 31ST JANUARY 2023
Legal Entity Identifier: 549300BGX3CJIHLP2H42
Information disclosed in accordance with the DTR 4.1.3
The Directors of The Mercantile Investment Trust plc announce the Company's results for the year ended 31st January 2023.
Chairman's Statement
Market Background
A series of extraordinary geopolitical and economic developments threw markets into turmoil over the year covered by this statement. Russia's invasion of Ukraine in February 2022 placed severe pressure on energy and commodity markets, adding to already worrying inflation trends. The forthright response of central banks, including the Bank of England, meant fears of inflation were replaced by fears of recession. UK financial markets were further destabilised by a mid-year policy vacuum and two new Prime Ministers. Liz Truss's tenure as Prime Minister proved very short, but nonetheless damaging, as investors resoundingly rejected her policies as radical, untested and unfunded. The appointment of former Chancellor Rishi Sunak as her replacement heralded a significant improvement in market sentiment and the UK market began to recover, outperforming its global counterparts in the final months of 2022. Despite recent upheavals in the global financial sector with the collapse of some US regional banks and the rescue of Credit Suisse, there are grounds for cautious optimism based on hopes that inflation, and thus interest rates, may have peaked, and that any UK recession will be shorter and shallower than feared previously.
Performance
As I reported in my Half Year statement, the first half of the year to the end of July 2022 saw the Company's NAV (based on debt at fair value) drop 11.5%. The NAV fell further after 1st August 2022 and reached its nadir in mid-September; however, I am pleased to report we have seen a marked improvement since then such that for the year to 31st January 2023, the Company's net asset total return, based on debt at fair was -8.5%; the second half performance has been 3.9 percentage points better than our benchmark. With the debt at par, the return for the year was -12.3%. Over the year, the share price discount to net asset value (with debt at fair) widened, from 9.7% to 12.6%, resulting in a total return to shareholders for the year of -11.0%. On all bases, the Company underperformed its benchmark, which declined by 7.5%.
This overall performance for the year is clearly disappointing, but since October there has been a much more positive feel to the market and indeed portfolio companies' businesses have largely performed well, delivering better than expected results. The performance during the year has been closely monitored by the Directors and the subject of much discussion between the Board and the Investment Managers. The Investment Managers' Report on the following pages discusses recent performance and portfolio changes in more detail, as well as considering their outlook for the coming year.
The Company's recent annual performance also needs to be assessed within the longer-term context in which the Company operates. On this basis, this year's underperformance follows a year of very strong absolute returns during the financial year ended 31st January 2022, and outperformance over five years and the longer term. The Company's average annualised return over the ten years ended 31st January 2023 was 8.8% per annum on a net asset total return fair value basis and +9.1% in share price terms, both returns outpacing the benchmark's return of +6.9%.
The Company's long term track record of high absolute returns and outperformance of the broader small and medium cap market attests to your Investment Managers' skill at identifying this sector's future market leaders and outperformers.
Returns and Dividends
The Company aims to provide shareholders with long term dividend growth at least in line with the rate of inflation over a five to ten year period, as detailed in the table below. The Company has paid three interim dividends of 1.35p per ordinary share in respect of the year to 31st January 2023 and the Board has declared a fourth quarterly interim dividend of 3.1 per share. This brings the total dividend for the year to 7.15p per share, an increase of 3.6% over last year.
CPI | Mercantile Dividend Growth | |
(% per annum) | (% per annum) | |
Three Years | 5.3% | 2.7% |
Five Years | 3.9% | 6.2% |
Ten Years | 2.7% | 7.1% |
Source: Office of National Statistics/J.P. Morgan
In deciding our dividend payments, we look to pay dividends that are at least covered by current year earnings, while also allowing us to build revenue reserves. However, it is a great advantage of the investment trust structure that the Company is able to partially fund dividend payments from revenue reserves when necessary to bolster the dividend during challenging times - something that the Company has done over the past three years. I am pleased to confirm that this is the first year since 2020 that the dividend is fully covered by earnings, meaning that the Company has not needed to draw on its reserves to partially fund the dividend. This has been possible because revenues per share over the past year increased by 10.6% to 7.19p, from 6.50p in the previous year. After payment of the fourth interim dividend, the Company will have revenue reserves of in excess of 4.9p per share (2022: 4.9p).
Discount
Over the year ended 31st January 2023, the Company's discount widened, ending the reporting period at 12.6%, from 9.7% at the same time the previous year. Your Directors recognise that it is in the interests of shareholders that the Company's share price does not differ excessively from the underlying NAV under normal market conditions. However, the past year's market conditions have been far from normal, and the widening of the Company's discount is consistent with the experience of investment companies across many asset classes. In an effort to equalise supply and demand in the face of this market turmoil, the Board utilised the Company's authority to buy back shares, repurchasing a total of 1,442,231 shares at a cost of £2.61 million. These shares were purchased at an average discount to NAV of 15.9%, producing a modest accretion to the NAV for continuing shareholders.
The Board closely monitors the discount and markets, and will continue to undertake share buybacks when it deems it appropriate. The Board therefore recommends that the powers to repurchase up to 14.99% of the Company's shares be renewed by shareholders at the forthcoming Annual General Meeting, with repurchased shares to be cancelled or held in Treasury. The Board is also seeking shareholder approval to issue shares at a premium to NAV and to disapply pre-emption rights on any such issues. As with buying shares at a discount, issuing new shares at a premium to NAV enhances returns to existing shareholders and improves liquidity.
Gearing
The Company ended the year with gearing of 9.5%. During the year, the level of gearing ranged between 4.8% and 14.2%. It is the Board's intention to continue to operate within the range of 10% net cash to 20% geared, under normal market conditions and having gone into the downturn mildly geared we were especially keen not to be ungeared into any upturn. Gearing is regularly discussed by the Board and the Investment Managers and is implemented via the use of long-dated, fixed-rate financing, from several sources, consistent with the Board's aim to ensure a diversification of source, tenure and cost of leverage available to the Company. The Company has in place a £3.85 million perpetual debenture and a £175 million debenture repayable on 25th February 2030, together with £150 million of long-term debt raised in September 2021 through the issue of three, fixed rate, senior unsecured privately placed notes (the 'Notes'). The Notes mature between 2041 and 2061 and were secured with a blended rate of 1.94%, at a time when interest rates were near their lows.
With inflation now in double digits and long-term interest rates significantly higher, the Company's borrowing profile is now very attractive, and should benefit shareholders, as it provides ample opportunity to enhance future returns, at relatively low cost.
Marketing, Promotion and Shareholder Interaction
The Company continues to raise its profile with investors and potential investors, via targeted media and promotional campaigns, and ongoing interaction with national and investment industry journalists. It is the Board's view that enhancing The Mercantile's profile will benefit all shareholders by creating sustained demand for its shares, particularly from retail investors, where demand has grown steadily in recent years. We seek to undertake this promotional activity in the most cost-effective manner.
The Board and the Investment Managers maintain a dialogue with the Company's shareholders via regular email updates, which deliver news and views, and discuss the latest performance. If you have not already signed up to receive these communications and you wish to do so, you can opt in via tinyurl.com/MRC-Sign-Up or by scanning the QR code which can be found in the Company's Annual Report & Accounts for the year ended 31st January 2023 ('2023 Annual Report').
To further promote the Company to the broader investment community, the Investment Managers follow an established marketing and investor relations programme targeting wealth managers, institutions and private client stockbrokers via video conferences, podcasts and in-person meetings.
It is the Board's hope that these initiatives will give many more of the Company's investors and potential investors the opportunity to interact with the Board and Investment Managers than has been the case in the past.
I and the Board welcome feedback from shareholders and any shareholder who wants to contact me should do so by contacting the Company Secretary on the details provided on page 95 of the 2023 Annual Report.
Environmental, Social and Governance ('ESG') Considerations
In their search for tomorrow's UK market leaders, our Investment Managers look beyond the near-term financial attributes of a company. As part of their efforts to identify businesses with sustainable business models and long-lasting competitive advantages, they scrutinise the environmental, social and governance ('ESG') aspects of the companies in which they invest. The Board shares the Investment Managers' view of the importance of ESG factors when making investments for the long term. For this reason, ESG considerations are fully integrated into the investment process. Equally importantly, the Investment Managers engage continually with investee companies on ESG issues, as well as on broader matters of company strategy and performance, throughout the duration of the investment, with the aim of fully understanding any ESG risks and encouraging investee companies to adopt best practice on ESG matters.
Further information on the Investment Manager's ESG process and engagement is set out in the ESG Report on pages 16 to 18 of the 2023 Annual Report.
Reporting under the Task Force on Climate Related Financial Disclosures
In accordance with the requirements of the Taskforce on Climate Related Financial Disclosures ('TCFD'), J.P. Morgan Asset Management will provide product level reports for the investment trusts it manages, including The Mercantile, in late June 2023 and annually thereafter. The report will be made available on the Company's website.
Key elements of the report will include Scope 1 and 2 greenhouse gas ('GHG') emissions (i.e. emissions that are owned or controlled by the Company), total carbon footprint, weighted average carbon intensity ('WACI') and, from June 2024, scope 3 GHG emissions (i.e. emissions generated as a consequence of the activities of Company but occur from sources not owned or controlled by it). The report will also include a scenario analysis of how climate change is likely to impact the Company's assets under orderly, disorderly and hothouse world scenarios, and discussion of the most significant drivers of performance under those scenarios.
Board Succession
Having served as a Director since 2012, Jeremy Tigue retired from the Board at the Annual General Meeting in May 2022. Graham Kitchen succeeded Jeremy in the roles of the Company's Senior Independent Director and Remuneration Committee Chairman. To spread the Board responsibilities more evenly, the role of Senior Independent Director was taken on by Rachel Beagles, with effect from 1st February 2023.
Harry Morley, who joined the Board in 2014, will be retiring at the forthcoming Annual General Meeting. On behalf of the Board, I would like to thank Harry for the significant contribution he has made to the Company and the wise counsel that he provided the Board during his tenure. We wish him well for the future. Damien Maltarp will succeed Harry in the role of Audit Committee Chairman.
The Board plans for succession to ensure it retains an appropriate balance of skills and knowledge. To this end, the Board was pleased to announce the appointment of Julia Goh with effect from 1st January 2023, and we look forward to working with her. For full details of Julia's experience and current roles please refer to pages 35 and 40. Following Harry's retirement, the Board will once again comprise six Directors.
In 2022, the FCA published new rules to encourage companies to be more transparent about the ethnic and gender diversity of their boards. The rules take effect for accounting periods starting after 1st April 2022, meaning that The Mercantile will need to report against these requirements from next year. However, I am able to confirm that the Company's Board constitution already complies with the FCA's ethnic and gender diversity guidelines for listed companies and the recommendations of the Hampton-Alexander Review concerning female representation on the Board. In the absence of any unforeseen circumstances, it is the intention that the Company will remain compliant with these requirements going forward.
The Manager
The Board, through its Management Engagement Committee, monitors the performance of the Manager, JPMorgan Funds Limited ('JPMF') on an ongoing basis. It is the Board's opinion that the Manager's long-term performance record remains strong. Based upon this record, and taking all factors into account, including other services provided to the Company and its shareholders, the Board is satisfied that JPMF should continue as the Company's Manager and that its ongoing appointment remains in the best interests of shareholders.
Annual General Meeting
The Company's one hundred and thirty seventh Annual General Meeting will be held at Trinity House, Tower Hill, London EC3N 4DH on Wednesday 24th May 2023 at 12.00 noon. In addition to the formal part of the meeting, there will be a presentation from the Investment Managers who will answer questions on the portfolio and performance. The meeting will be followed by a buffet lunch which will give shareholders an opportunity to meet the Board, the Investment Managers and representatives of J.P. Morgan.
Outlook
Even though there has been significant disruption in the global financial sector recently, following the collapse of some US regional banks and the takeover and rescue of Credit Suisse in Europe, and therefore the resultant jitters in markets, I am pleased to say that the outlook for your Company and our investments appears considerably brighter now than when I sat down in October last year to write my statement for the Company's Half Year Report. As our Investment Managers have said, credit markets may tighten somewhat but the financial sector in the UK and our companies in particular are in a much healthier position. Although the tragic war in Ukraine drags on, its impact on energy and commodity prices is beginning to ease. There are signs that inflation may be peaking, and while central banks are unlikely to begin easing monetary policy any time soon, interest rates may stabilise, while monetary authorities take time to assess the medium-term inflation outlook. In addition, forecasts suggest that the UK economy, will, at worst, experience a mild recession this year. Furthermore, the UK's political climate has calmed considerably, with an improvement in relations with the EU and a new Pan Pacific trade agreement. The potential for UK companies to increase business is encouraging.
The UK market remains attractively priced relative to many of its global counterparts, and with sterling still weak, the market is likely to see continued interest from foreign investors, and private equity firms and others seeking to acquire UK companies. These factors should continue to support the market.
The recovery in your Company's fortunes in the second half of the financial year suggests that the portfolio is well-positioned to continue benefitting from the improving economic and market environment, and the Board shares the Investment Managers' confidence in their strategy, the portfolio and the Company's prospects for capital and dividend growth over the coming year and over the long term.
We thank you for your ongoing support.
Angus Gordon Lennox Chairman
3rd April 2023
Investment Managers' Report
Setting the scene: Challenging times give way to signs of improvement
This has been an especially challenging year for financial markets. Having recovered from pandemic-driven losses and climbed to all-time highs, equity markets subsequently struggled following the Russian invasion of Ukraine, as investors digested the conflict's multitude of first- and second-order knock-on effects. Existing pandemic-induced supply side constraints, combined with rising and broad-based inflation, were exacerbated by the conflict, with energy supplies and prices under pressure. Against such a backdrop, central banks surprised investors by the pace and extent of monetary tightening, which in turn fuelled fears of global recession.
Political instability in the UK added further to this negative dynamic. Investor confidence was unsettled as the ruling Conservative party faced a series of scandals which eventually led to a change of leadership. The incoming Truss administration's attempts to boost growth by implementing unfunded corporate and individual tax cuts, alongside a two-year energy price guarantee, were greeted with widespread criticism and market scepticism. This triggered a surge in financial market volatility: equity markets dropped sharply, the pound briefly hit an all-time low against the US dollar, and gilts yields rose so sharply the Bank of England was forced to implement a multi-day bond-buying programme to stabilise bond markets.
At its nadir in mid-October, the Company's target market of UK medium and smaller companies (the 'benchmark'), had declined by 25% over the financial year-to date. However, the appointment of former Chancellor Rishi Sunak as Prime Minister to replace Truss, and Sunak's subsequent reversal of several of her most controversial policies, calmed markets. Investors were further reassured by a decline in energy prices thanks to a mild winter, which raised hopes that inflation was approaching a peak, while fears of a serious recession were assuaged by resilient consumption. These factors, combined to fuel a significant recovery in UK equity markets, which have in fact outperformed other major markets in recent months. UK medium and small cap companies benefitted from this recovery, allowing this part of the market to claw back a portion of its previous losses, closing the financial year ended 31st January 2023 down a more modest 7.5%.
Mercantile performance
Against this backdrop, the Company delivered a return on net assets, with debt measured at par value, of -12.3%. With debt at fair value, this decline was -8.5%.
It is worthy of note that all of this underperformance occurred in the first half of the year, driven by a combination of two factors. The first was stock selection, which detracted mainly due to the portfolio's substantial overweight to consumer discretionary stocks that were especially hard-hit by rising inflation and interest rates. The second was gearing, which impacted performance as the trust remained geared into a declining market.
However, relative performance began to improve in the second half of the year, supported by the recovery in market sentiment, the better-than-feared macroeconomic outlook, and portfolio adjustments made in response to events in the first half of the year, although the pick-up in performance has not yet been sufficient to recoup the Company's first half losses.
To under-perform over the course of the year has been frustrating as portfolio companies have for the most part continued to deliver financial results, including dividends to shareholders, ahead of the market's expectations, while the broader market has disappointed. This is partly a result of a decline in valuations ascribed by the market to many of the higher quality, structurally growing businesses in which we invest, reflecting higher discount rates and cautious sentiment.
PERFORMANCE ATTRIBUTION
FOR THE YEAR ENDED 31ST JANUARY 2023
Performance attribution analyses how the Company achieved its recorded performance relative to its benchmark index.
% | % | |
Contributions to total return | ||
Benchmark total return | -7.5% | |
Allocation/Stock/Sector Effect | -2.5% | |
Effect of Cash & Gearing | -1.2% | |
Cost of Debentures and Senior Unsecured Privately Placed Loan Notes | -0.6% | |
Portfolio Total Return | -11.8% | |
Management Fees/Other Expenses | -0.5% | |
Share Buy-Back/Issuance | 0.0% | |
Cum Par Net Asset Value Total ReturnAPM | -12.3% | |
Impact of Debt Valuation | 3.8% | |
Cum Fair Net Asset Value Total ReturnAPM | -8.5% |
APM Alternative Performance Measure ('APM').
Source: JPMAM and Morningstar. All figures are on a total return basis.
Contributions calculated using an Arithmetic methodology.
A glossary of terms and APMs is provided on pages 91 to 93 of the 2023 Annual Report.
Spotlight on stocks
Winners
Portfolio highlights in the past year included our longstanding investment in Telecom Plus, a multi-utility provider with an everyday low-price proposition, which has been a beneficiary of the changing landscape in the energy supply market. This had been a modestly sized position for several years, but we increased exposure dramatically in late 2021 and early 2022 as the competitive landscape evolved in their favour, increasing the potential for accelerated growth in the company's customer base. We also enjoyed success with our investment in 4Imprint, a provider of branded promotional materials for corporates. Its recovery from the pandemic accelerated as conferences and trade fairs resumed. Growth in new clients has been particularly strong. Finally, another long-term holding, in asset manager Brewin Dolphin, was subject to an agreed takeover by Royal Bank of Canada (RBC), which came at a handsome premium.
Losers
On the negative side, as mentioned above, our holdings in consumer-facing companies such as Watches of Switzerland, a luxury watch retailer, and Jet2, an airline and holiday company, detracted from performance. While the operational performance of both these businesses has remained encouraging, with continued growth in earnings and a promising long-term growth runway ahead, their shares came under pressure due to understandable concerns about the outlook for discretionary spending.
Elsewhere, our investment in Future, a specialist media company, was disappointing. Having built the business through a series of acquisitions alongside impressive organic revenue growth and profitability gains, the CEO announced her intention to step down once a successor had been appointed. This, combined with market concerns regarding the outlook for media spending and e-commerce activity through a widely-anticipated recession, put the share price under sustained pressure during the year.
Positioning the portfolio for future success
We target UK companies outside of the FTSE 100 Index that have significant opportunities for growth and which may be overlooked by other investors. We invest in the shares of companies that we believe possess the characteristics that may facilitate this growth, for example nimble business models that can innovate or disrupt their industries, or companies that occupy prime positions in rapidly growing markets.
Through the course of any individual year there are adjustments to the portfolio to reflect the changing environment, as investment hypotheses run their course or are proved invalid, or as share price moves open up better opportunities elsewhere. Over the past few years there have been several turning points for markets as well as numerous changes to the operating environments of our portfolio companies. Despite this, turnover has remained somewhat lower than long-term averages, reflecting what we believe to be a resiliently positioned portfolio and a clear focus on the long-term prospects of our holdings.
The last few years have presented a particularly volatile operating environment for many companies, with Brexit uncertainty, pandemic restrictions, supply chain challenges, surging inflation, war in Europe and open talk of souring East-West relations. We believe that this backdrop has made it even more important to focus on well-positioned and well-managed businesses that have the resilience to cope and even thrive in such a situation, and which may ultimately emerge with stronger competitive positions. Furthermore, given the broadly negative narrative surrounding the UK and its economic prospects, the valuations of UK stocks - including valuations of the future winners - have reduced, which presents a compelling investment proposition.
In view of the deterioration in the economic outlook, we made some notable changes to the portfolio over the first half of the year. The most material of these was the reduction in exposure to the consumer discretionary sector, offset by increases in the telecommunications and energy sectors. However, despite the reduction in consumer discretionary holdings such as DFS and Moonpig, consumer facing stocks remain an important area of the portfolio, including some of our largest individual investments, such as Watches of Switzerland, Dunelm, the UK's leading homewares retailer, and WH Smith, a travel retailer. In each of these cases, it is noteworthy that growth is being underpinned by improving customer propositions and resultant increases in market share, rather than being solely dependent on the strength of consumer demand.
The portfolio's exposure to energy has been increased both directly, via investments in energy producers such as Harbour Energy that are set to benefit from higher oil and gas prices, and indirectly, via companies providing goods and services to the energy industry and indeed those that distribute it, such as the aforementioned investment in Telecom Plus.
At the sector level, Support Services is now our largest overweight position, with example holdings including our longstanding investments in Inchcape, the vehicle distributor, and the industrial and electronic product distributors Diploma and RS Group. The Software & Computer Services sector remains another substantial overweight for the portfolio, with example holdings including Softcat, one of the UK's leading value-added technology resellers, Computacenter, a leading technology services provider to large corporate and public sector organisations, and Big Technologies, the provider of electronic monitoring systems primarily to criminal justice systems around the world.
The portfolio also retains substantial investments in the industrial sectors. Two such examples are IMI and Rotork, engineering companies that design, manufacture and service a range of complex and often customised products that control the movement of fluids and gases in a host of different industries. In both cases the business leadership has re-emphasised the commercial focus, aligning new product development more closely with customer needs and thus driving higher growth.
We have a number of holdings in the financial services industry, including a large investment in the buy-to-let lender OSB Group. While recent events in the banking industry have re-emphasised the risks associated with certain business models, we are reassured by the high profitability, appropriate capitalisation and diverse funding sources of our holdings, which should position them for continued success. We maintained our very large underweight in the real estate sector on the expectation that valuations could come under downward pressure in an environment of potentially rapid increases to interest rates and thus the discount rates upon which property valuations are based. Having witnessed at least a major portion of this expected reset, we recently made an initial foray back into this sector, taking a modest position in LondonMetric Property, a diversified REIT.
Outlook for the coming year
The economic outlook today is far from rosy, yet there are reasons for cautious optimism. The US regional bank failures and the takeover of Credit Suisse by UBS have sent shockwaves through the financial system and may lead to further credit tightening, but at this time appear unlikely to materially impact UK banks and their ability to lend, given their stronger profitability and liquidity. In addition, a less intense inflationary environment and continued recovery from the pandemic, have the potential to support economic growth, with the UK now expected to avoid a recession. Against this backdrop, valuations of UK equities have fallen, and despite the recent outperformance of the UK market, this de-rating has created some exciting investment opportunities.
Despite the natural and widespread caution in outlook statements, portfolio companies are for the most part performing well, and we believe they possess the wherewithal to withstand near-term challenges and continue to thrive and grow. While there is naturally nervousness around the near-term outlook, we have a positive view as expressed by the portfolio's 10% gearing and are excited by the opportunities that we see.
We will maintain our focus on investing in high quality businesses that operate in growing end markets with the ability to invest capital at attractive returns and which can also adapt to the changing environments in which they operate. We believe that a portfolio of such investments offers the best prospect of delivering compelling returns for our shareholders over the long-term.
Guy Anderson
Anthony Lynch
Investment Managers
3rd April 2023
Principal and Emerging Risks
The Directors confirm that they have carried out a robust assessment of the principal risks facing the Company, including those that would threaten its business model, future performance, solvency or liquidity. With the assistance of JPMF, the Audit Committee has drawn up a risk matrix, which identifies the key risks to the Company. These are reviewed and noted by the Board. The key risks identified and the broad categories in which they fall, and the ways in which they are managed or mitigated are summarised below. The key principal risks identified by the Audit Committee are unchanged from the prior year. The AIC Code of Corporate Governance requires the Audit Committee to put in place procedures to identify emerging risks. The key emerging risks identified are also summarised below.
Principal risk | Description | Mitigating activities |
Investment Management and Performance | ||
Underperformance | Poor implementation of the investment strategy, for example as to thematic exposure, sector allocation, stock selection, undue concentration of holdings, factor risk exposure or the degree of total portfolio risk, may lead to underperformance against the Company's benchmark index and peer companies. | This risk is managed by diversification of investments and through its investment restrictions and guidelines, which are monitored and reported on by the Manager. The Manager provides the Directors with timely and accurate management information, including performance data and attribution analyses, revenue estimates, liquidity reports and shareholder analyses. The Board monitors the implementation and results of the investment process with the Investment Managers, at least one of whom attends all Board meetings, and reviews data which show measures of the Company's risk profile. The Investment Managers employ the Company's gearing tactically, within a strategic range set by the Board. The Board holds a separate meeting devoted to strategy each year. |
Market and Economic Risk | Market risk arises from uncertainty about the future prices of the Company's investments, which may reflect underlying uncertainties arising from economic, social, fiscal, climate and regulatory changes. In the past few years the COVID-19 pandemic has been a major source of uncertainty and has contributed to elevated levels of market volatility, whilst more recently interest rate risk has also become a key driver of market and economic uncertainty. Geopolitical risks have risen markedly following the Russian invasion of Ukraine. While direct linkages to the UK from Russia tend to be small, the impact of sanctions has been significant and the rise in commodity prices has lead to a cost of living crisis in the UK, which has hindered the Company's holdings in the consumer sectors in particular. These risks represent the potential loss the Company might suffer through holding investments in the face of negative market movements. | This risk is managed to some extent by diversification of investments and by regular communication with the Manager on matters of investment strategy and portfolio construction which will directly or indirectly include an assessment of these risks. The Board receives regular reports from the Manager regarding market outlook and gives the Investment Mangers discretion regarding acceptable levels of gearing and/or cash. Currently the Company's gearing policy is to operate within a range of 10% net cash to 20% geared. The Board considers thematic and factor risks, stock selection and levels of gearing on a regular basis and has set investment restrictions and guidelines which are monitored and reported on by the Manager. The Board can, with shareholder approval, look to amend the investment policy and objectives of the Company to gain exposure to or mitigate the risks arising from geopolitical instability. |
Corporate Strategy | The corporate strategy, including the investment objectives and policies, may not be of sufficient interest to current or prospective shareholders. Other factors, such as the Company not being classified as an ESG integrated investment vehicle, may also deter shareholder interest. | Our investment strategies aim to position The Mercantile as a clear and core investment choice available for investment through a number of channels. The Manager continues to deliver on the Company's objective and integrates ESG considerations into its investment process. The Board regularly reviews its strategy, and assesses, with its brokers, shareholder views. Marketing and investor relations campaigns continued throughout the year and we have identified appropriate promotional opportunities for the Company (including advertising, events and research coverage) in order to maintain a strong platform presence. A Mercantile 'Preference Centre' has been set up to provide the Company with the ability to communicate directly and more effectively with investors. |
Discount Control Risk | Investment trust shares often trade at discounts to their underlying NAVs, although they can also trade at a premium. Discounts and premiums can fluctuate considerably leading to volatile returns for shareholders. | The Board monitors the level of both the absolute and sector relative premium/discount at which the shares trade. The Board reviews both sales and marketing activity and sector relative performance, which it believes are the primary drivers of the relative discount level. In addition, the Company has authority, when it deems appropriate, to buy back its existing shares to enhance the NAV per share for remaining shareholders and to reduce the absolute level of discount and discount volatility. |
Operational Risks | ||
Mid and Smaller Company Investment | Investing in mid and smaller sized companies is inherently more risky and volatile, partly due to a potential lack of liquidity in the shares, which could lead to the Investment Managers obtaining a lower market price in the extremely rare event of them being forced sellers. | The Board discusses these risk factors at each Board meeting with the Investment Managers. The Board has placed investment restrictions and guidelines to limit these risks. Ultimately the Company is protected to some extent given its closed end structure. |
Cyber Crime | The threat of cyber attack, in all guises, is regarded as at least as important as more traditional physical threats to business continuity and security. In addition to threatening the Company's operations, such an attack is likely to raise reputational issues which may damage the Company's share price and reduce demand for its shares. | The Company benefits directly or indirectly from all elements of JPMorgan's cyber security programme. The Board reviews the cyber security precautions taken by its third party suppliers on a regular basis. The information technology controls around the physical security of JPMorgan's data centres, security of its networks and security of its trading applications are tested by independent reporting accountants and reported on every six months against the AAF Standard. |
Regulatory Risks | ||
Regulatory Change | The Company's business model could become non-viable as a result of new or revised rules or regulations arising from, for example, policy change or financial monitoring pressure. | The Board receives regular reports from its broker, depositary, registrar and Manager as well as its legal advisers and the industry trade body (the Association of Investment Companies) on changes to regulations which could impact the Company and its industry. The Company monitors events and relies on the Manager and its other key third party providers to manage this risk by preparing for any changes, adverse or otherwise. |
Emerging risks | Description | Mitigating activities |
Environmental Risks | ||
Climate Change | Climate change is one of the most critical emerging issues confronting asset managers and their investors. Climate change may have a disruptive effect on the business models and profitability of individual investee companies, and indeed, whole sectors. | The Manager's investment process integrates consideration of environmental, social and governance factors into decisions on which stocks to buy, hold or sell. This includes the approach investee companies take to recognising and mitigating climate change risks. In the Company's and Manager's view, companies that successfully manage climate change risks will perform better in the long-term. Consideration of climate change risks and opportunities is an integral part of the investment process. |
ESG requirements from investors | The Company's policy on ESG and climate change may be out of line with ESG practices which investors are looking to invest in accordance with. | The Manager has integrated the consideration of ESG factors into the Company's investment process. Further details are set out in the ESG report on pages 16 to 18. |
Pandemic Risks | ||
Pandemics | The emergence of COVID-19 illustrated the speed and extent of economic damage that can arise from a pandemic. Whilst the impact of COVID-19 has now subsided, at least in the UK, pandemics in general remain an emerging risk. Evidence suggests that the likelihood of pandemics has increased over the past century due to increased global travel and integration, urbanisation, changes in land use, and greater exploitation of the natural environment. | During the COVID-19 pandemic the Board received reports on the business continuity plans of the Manager and other key service providers. The effectiveness of these measures was assessed throughout the course of the COVID-19 pandemic and no issues were identified. The Board is mindful that implications arising from future pandemics will vary and hence the ability to assess mitigation activities is unknown. |
Geopolitical Risks |
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Geopolitical Instability | Geopolitical Risk is the potential for political, socio-economic and cultural events and developments to have an adverse effect on the value of the Company's assets. The Company and its assets may be impacted by geopolitical instability, in particular concerns over global economic growth. The crisis in Ukraine has already affected energy and commodity markets and may cause further damage to the global economy. The ongoing conflict between Russia and Ukraine has heightened the possibility that tensions will spill over and intensify geopolitical unrest between other countries sharing a common border. | There is little direct control of this risk possible. The Company addresses these global developments in regular questioning of the Manager, including challenging the Manager on the extent of geopolitical exposure within individual investee companies, or the portfolio more broadly. The Board has the ability, with shareholder approval, to amend the policy and objectives of the Company to mitigate the risks arising from geopolitical concerns. |
Transactions with the Manager and related parties
Details of the management contract are set out in the Directors' Report on page 37 of the 2023 Annual Report. The management fee payable to the Manager for the year was £6,907,000 (2022: £9,191,000) of which £nil (2022: £nil) was outstanding at the year end.
Included in administration expenses in note 6 on page 69 of the 2023 Annual Report are safe custody fees amounting to £32,000 (2022: £50,000) payable to JPMorgan Chase of which £7,000 (2022: £4,000) was outstanding at the year end.
The Manager may carry out some of its dealing transactions through group subsidiaries. These transactions are carried out at arm's length.
During the year, brokerage commission on dealing transactions amounting to £1,000 (2022: £44,000) was payable to JPMorgan subsidiaries of which £nil (2022: £nil) was outstanding at the year end.
The Company also holds cash in JPMorgan Sterling Liquidity Fund, managed by JPMorgan. At the year end this was valued at £157.2 million (2022: £62.9 million). Interest income amounting to £3,036,000 (2022: £30,000) was receivable during the year of which £nil (2022: £nil) was outstanding at the year end.
Handling charges on dealing transactions amounting to £14,000 (2022: £15,000) were payable to JPMorgan Chase during the year of which £2,000 (2022: £5,000) was outstanding at the year end.
At the year end, total cash of £386,000 (2022: £2,765,000) was held with JPMorgan Chase. A net amount of interest of £113,000 (2022: £3,000) was receivable by the Company during the year from JPMorgan Chase of which £nil (2022: £nil) was outstanding at the year end.
Full details of Directors' remuneration and shareholdings can be found on page 49 and in note 6 on page 69 of the 2023 Annual Report.
Statement of Directors' Responsibilities
The Directors are responsible for preparing the Annual Report and the Financial Statements in accordance with applicable law and regulations.
Company law requires the Directors to prepare financial statements for each financial year. Under that law, the Directors have elected to prepare the financial statements in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards, comprising Financial Reporting Standard 102, the Financial Reporting Standard applicable in the UK and Republic of Ireland ('FRS 102') and applicable law). Under Company law the Directors must not approve the financial statements unless they are satisfied that taken as a whole, the Annual Report and Financial Statements are fair, balanced and understandable, provide the information necessary for shareholders to assess the Company's position and performance, business model and strategy and that they give a true and fair view of the state of affairs of the Company and of the total return or loss of the Company for that period. In order to provide these confirmations, and in preparing these financial statements, the Directors are required to:
· select suitable accounting policies and then apply them consistently;
· make judgements and estimates that are reasonable and prudent;
· state whether applicable UK Accounting Standards, comprising FRS 102, have been followed, subject to any material departures disclosed and explained in the financial statements;
· prepare the financial statements on a going concern basis unless it is inappropriate to presume that the Company will continue in business; and
· notify the Company's shareholders in writing about the use, if any, of disclosure exemptions in FRS 102 in the preparation of the financial statements
and the Directors confirm that they have done so.
The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and to enable them to ensure that the financial statements comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.
Under applicable law and regulations the Directors are also responsible for preparing a Directors' Report and Directors' Remuneration Report that comply with that law and those regulations.
Each of the Directors, whose names and functions are listed on pages 35 and 36 of the 2023 Annual Report confirms that, to the best of his/her knowledge, the financial statements, which have been prepared in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards and applicable law), give a true and fair view of the assets, liabilities, financial position and net return or loss of the Company.
The Board confirms that it is satisfied that the Annual Report and Financial Statements taken as a whole are fair, balanced and understandable and provide the information necessary for shareholders to assess the Company's position and performance, business model and strategy.
The Board also confirms that it is satisfied that the Strategic Report and Directors' Report include a fair review of the development and performance of the business, and the Company, together with a description of the principal risks and uncertainties that it faces.
The Financial Statements are published on the www.mercantileit.co.uk website, which is maintained by the Manager. The maintenance and integrity of the website maintained by the Manager is, so far as it relates to the Company, the responsibility of the Manager. The work carried out by the Auditor does not involve consideration of the maintenance and integrity of this website and, accordingly, the Auditor accepts no responsibility for any changes that have occurred to the accounts since they were initially presented to the website. The accounts are prepared in accordance with UK legislation, which may differ from legislation in other jurisdictions.
For and on behalf of the BoardAngus Gordon LennoxChairman
3rd April 2023
Statement of Comprehensive Income
For the year ended 31st January
2023 | 2022 | |||||
Revenue | Capital | Total | Revenue | Capital | Total | |
£'000 | £'000 | £'000 | £'000 | £'000 | £'000 | |
(Losses)/gains on investments held at fair value through profit or loss | - | (317,548) | (317,548) | - | 228,162 | 228,162 |
Net foreign currency gains | - | 64 | 64 | - | 23 | 23 |
Income from investments | 61,589 | - | 61,589 | 60,986 | - | 60,986 |
Interest receivable and similar income | 3,149 | - | 3,149 | 33 | - | 33 |
Gross return/(loss) | 64,738 | (317,484) | (252,746) | 61,019 | 228,185 | 289,204 |
Management fee | (2,072) | (4,835) | (6,907) | (2,757) | (6,434) | (9,191) |
Other administrative expenses | (1,413) | - | (1,413) | (1,439) | - | (1,439) |
Net return/(loss) before finance costs and taxation | 61,253 | (322,319) | (261,066) | 56,823 | 221,751 | 278,574 |
Finance costs | (4,245) | (9,906) | (14,151) | (3,851) | (8,984) | (12,835) |
Net return/(loss) before taxation | 57,008 | (332,225) | (275,217) | 52,972 | 212,767 | 265,739 |
Taxation | (128) | - | (128) | (1,494) | - | (1,494) |
Net return/(loss) after taxation | 56,880 | (332,225) | (275,345) | 51,478 | 212,767 | 264,245 |
Return/(loss) per share | 7.19p | (42.02)p | (34.83)p | 6.50p | 26.88p | 33.38p |
All revenue and capital items in the above statement derive from continuing operations. No operations were acquired or discontinued in the year.
The 'Total' column of this statement is the profit and loss account of the Company and the 'Revenue' and 'Capital' columns represent supplementary information prepared under guidance issued by the Association of Investment Companies. Net return/(loss) after taxation represents the profit/(loss) for the year and also total comprehensive income/(loss).
The notes on pages 66 to 83 of the 2023 Annual Report form an integral part of these financial statements.
Statement of Changes in Equity
For the year ended 31st January
Called up | Capital | |||||
share | Share | redemption | Capital | Revenue | ||
capital | premium | reserve | reserves1 | reserve1 | Total | |
£'000 | £'000 | £'000 | £'000 | £'000 | £'000 | |
At 31st January 2021 | 23,612 | 23,459 | 13,158 | 1,863,612 | 63,158 | 1,986,999 |
Net return | - | - | - | 212,767 | 51,478 | 264,245 |
Dividends paid in the year (note 3) | - | - | - | - | (53,033) | (53,033) |
At 31st January 2022 | 23,612 | 23,459 | 13,158 | 2,076,379 | 61,603 | 2,198,211 |
Repurchase of shares into Treasury | - | - | - | (2,623) | - | (2,623) |
Net (loss)/return | - | - | - | (332,225) | 56,880 | (275,345) |
Dividends paid in the year (note 3) | - | - | - | - | (54,567) | (54,567) |
At January 2023 | 23,612 | 23,459 | 13,158 | 1,741,531 | 63,916 | 1,865,676 |
1 These reserves form the distributable reserves of the Company and may be used to fund distributions to shareholders.
Statement of Financial Position
At 31st January
2023 | 2022 | |
£'000 | £'000 | |
Fixed assets | ||
Investments held at fair value through profit or loss | 2,042,758 | 2,465,122 |
Current assets | ||
Debtors | 2,737 | 4,271 |
Cash and short term deposits | 386 | 2,765 |
Cash equivalents: liquidity fund | 157,220 | 62,896 |
160,343 | 69,932 | |
Creditors: amounts falling due within one year | (9,599) | (9,124) |
Net current assets | 150,744 | 60,808 |
Total assets less current liabilities | 2,193,502 | 2,525,930 |
Creditors: amounts falling due after more than one year | (327,826) | (327,719) |
Net assets | 1,865,676 | 2,198,211 |
Capital and reserves | ||
Called up share capital | 23,612 | 23,612 |
Share premium | 23,459 | 23,459 |
Capital redemption reserve | 13,158 | 13,158 |
Capital reserves | 1,741,531 | 2,076,379 |
Revenue reserve | 63,916 | 61,603 |
Total shareholders' funds | 1,865,676 | 2,198,211 |
Net asset value per share | 236.1p | 277.7p |
Statement of Cash Flows
For the year ended 31st January
2023 | 2022 | |
£'000 | £'000 | |
Net cash outflow from operations before dividends and interest | (8,172) | (10,642) |
Dividends received | 62,063 | 58,827 |
Interest received | 3,149 | 34 |
Overseas tax recovered | 604 | 429 |
Interest paid | (14,058) | (11,638) |
Net cash inflow from operating activities | 43,586 | 37,010 |
Purchases of investments | (507,308) | (693,957) |
Sales of investments | 612,839 | 682,614 |
Settlement of foreign currency contracts | - | 7 |
Net cash inflow/(outflow) from investing activities | 105,531 | (11,336) |
Dividends paid | (54,567) | (53,033) |
Repurchase of shares into Treasury | (2,623) | - |
Drawdown of loans | - | 149,659 |
Repayment of loan | - | (80,000) |
Net cash (outflow)/inflow from financing activities | (57,190) | 16,626 |
Increase in cash and cash equivalents | 91,927 | 42,300 |
Cash and cash equivalents at start of year | 65,661 | 23,347 |
Exchange movements | 18 | 14 |
Cash and cash equivalents at end of year | 157,606 | 65,661 |
Cash and cash equivalents consist of: | ||
Cash and short term deposits | 386 | 2,765 |
Cash held in JPMorgan Sterling Liquidity Fund | 157,220 | 62,896 |
Total | 157,606 | 65,661 |
Reconciliation of net debt
As at | Other | As at | ||
31st January | non-cash | 31st January | ||
2022 | Cash flows | movements | 2023 | |
£'000 | £'000 | £'000 | £'000 | |
Cash and cash equivalents | ||||
Cash | 2,765 | (2,397) | 18 | 386 |
Cash equivalents | 62,896 | 94,324 | - | 157,220 |
65,661 | 91,927 | 18 | 157,606 | |
Borrowings: | ||||
Debentures falling due after more than five years | (178,060) | - | (97) | (178,157) |
Private Placement due after more than five years | (149,659) | - | (10) | (149,669) |
(327,719) | - | (107) | (327,826) | |
Net debt | (262,058) | 91,927 | (89) | (170,220) |
Notes to the Financial Statements
1. Accounting policies
(a) Basis of accounting
The financial statements have been prepared in accordance with the Companies Act 2006, FRS 102 'The Financial Reporting Standard applicable in the UK and Republic of Ireland' of the United Kingdom Generally Accepted Accounting Practice ('UK GAAP') and with the Statement of Recommended Practice 'Financial Statements of Investment Trust Companies and Venture Capital Trusts' (the 'SORP') issued by the Association of Investment Companies in July 2022.
All of the Company's operations are of a continuing nature.
The financial statements have been prepared on a going concern basis. The disclosures on going concern on page 43 of the Directors' Report in the 2023 Annual Report form part of these financial statements.
The policies applied in these accounts are consistent with those applied in the preceding year.
2. Return/(loss) per share
| 2023 | 2022 |
| £'000 | £'000 |
Revenue return | 56,880 | 51,478 |
Capital (loss)/return | (332,225) | 212,767 |
Total (loss)/return | (275,345) | 264,245 |
Weighted average number of shares in issue during the year | 790,696,064 | 791,522,893 |
Revenue return per share | 7.19p | 6.50p |
Capital (loss)/return per share | (42.02)p | 26.88p |
Total (loss)/return per share | (34.83)p | 33.38p |
The total (loss)/return per share represents both basic and diluted return per share as the Company has no dilutive shares.
3. Dividends
(a) Dividends paid and declared
|
| 2023 | 2022 | |
|
| £'000 | £'000 | |
Dividends paid | ||||
2022 fourth quarterly dividend of 2.85p (2021: 2.65p) paid to shareholders in May 20221 | 22,558 | 20,975 | ||
First quarterly dividend of 1.35p (2022: 1.35p) paid to shareholders in August 20221 | 10,677 | 10,686 | ||
Second quarterly dividend of 1.35p (2022: 1.35p) paid to shareholders in November 20221 | 10,666 | 10,686 | ||
Third quarterly dividend of 1.35p (2022: 1.35p) paid to shareholders in February 20231 | 10,666 | 10,686 | ||
Total dividends paid in the year | 54,567 | 53,033 | ||
|
| 2023 | 2022 |
|
| £'000 | £'000 |
Dividend declared | |||
Fourth quarterly dividend declared of 3.1p (2022: 2.85p) payable to shareholders in May 20231 | 24,493 | 22,558 |
1 The Company irrevocably transfers the funds to its Registrar in the month prior to which the dividend is paid to shareholders.
All dividends paid and proposed in the year have been funded from the revenue reserve.
The fourth quarterly dividend has been declared in respect of the year ended 31st January 2023. In accordance with the accounting policy of the Company, these dividends will be reflected in the financial statements for the year ending 31st January 2024.
(b) Dividends for the purposes of Section 1158 of the Corporation Tax Act 2010 ('Section 1158')
The requirements of Section 1158 are considered on the basis of dividends declared in respect of the financial year as shown below. The revenue available for distribution by way of dividend for the year is £56,880,000 (2022: £51,478,000).
The maximum amount of income that the Company is permitted to retain under Section 1158 is £9,711,000 (2022: £9,153,000), calculated as 15% of total income. Therefore the minimum distribution required by way of dividend is £47,169,000 (2022: £42,325,000).
|
| 2023 | 2022 |
|
| £'000 | £'000 |
First quarterly dividend of 1.35p (2022: 1.35p) paid to shareholders in August 20221 | 10,677 | 10,686 | |
Second quarterly dividend of 1.35p (2022: 1.35p) paid to shareholders in November 20221 | 10,666 | 10,686 | |
Third quarterly dividend of 1.35p (2022: 1.35p) paid to shareholders in February 20231 | 10,666 | 10,686 | |
Fourth quarterly dividend declared of 3.1p (2022: 2.85p) payable in May 20231 | 24,493 | 22,558 | |
56,502 | 54,616 |
1 The Company irrevocably transfers the funds to its Registrar in the month prior to which the dividend is paid to shareholders.
4. Net asset value per share
The net asset value per Ordinary share and the net asset value attributable to the Ordinary shares at the year end are shown below. These were calculated using 790,080,662 (2022: 791,552,893) Ordinary shares in issue at the year end (excluding Treasury shares).
| 2023 | 2022 | ||
| Net asset value attributable | Net asset value attributable | ||
£'000 | pence | £'000 | pence | |
Net asset value - debt at par | 1,865,676 | 236.1 | 2,198,211 | 277.7 |
Add: amortised cost of £175 million 6.125% debenture stock 25th February 2030 | 174,307 | 22.1 | 174,210 | 22.0 |
Less: fair value of £175 million 6.125% debenture stock 25th February 2030 | (201,864) | (25.5) | (232,730) | (29.4) |
Add: amortised cost of £3.85 million 4.25% perpetual debenture stock | 3,850 | 0.5 | 3,850 | 0.5 |
Less: fair value of £3.85 million 4.25% perpetual debenture stock | (3,791) | (0.5) | (8,473) | (1.0) |
Add: amortised cost of senior unsecured privately placed loan notes | 149,669 | 18.9 | 149,659 | 18.9 |
Less: fair value of senior unsecured privately placed loan notes | (93,602) | (11.8) | (145,272) | (18.4) |
Net asset value - debt at fair value | 1,894,245 | 239.8 | 2,139,455 | 270.3 |
5. Status of results announcement
2022 Financial Information
The figures and financial information for 2022 are extracted from the Annual Report and Financial Statements for the year ended 31st January 2022 and do not constitute the statutory accounts for the year. The Annual Report and Financial Statements include the Report of the Independent Auditors which was unqualified and did not contain a statement under either section 498(2) or section 498(3) of the Companies Act 2006.
2023 Financial Information
The figures and financial information for 2023 are extracted from the published Annual Report and Financial Statements for the year ended 31st January 2023 and do not constitute the statutory accounts for that year. The Annual Report and Financial Statements include the Report of the Independent Auditors which is unqualified and did not contain a statement under either section 498(2) or section 498(3) of the Companies Act 2006. The Annual Report and Financial Statements for the year ended 31st January 2023 will be delivered to the Register of Companies in due course.
Neither the contents of the Company's website nor the contents of any website accessible from hyperlinks on the Company's website (or any other website) is incorporated into, or forms part of, this announcement.
3rd April 2023
For further information:
Alison Vincent,
JPMorgan Funds Limited
020 7742 4000
ENDS
A copy of the annual report will shortly be submitted to the FCA's Electronic Submission System and will be available for inspection at https://data.fca.org.uk/#/nsm/nationalstoragemechanism
The annual report will shortly be available on the Company's website at www.mercantileit.co.uk where up-to-date information on the Company, including daily NAV and share prices, factsheets and portfolio information can also be found.
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JPMORGAN FUNDS LIMITED